Risk Assets Responding to Quantitative Easing

With even the 'new
normal' crowd upgrading their economic forecasts for 2011, the Federal
Reserve prepared to fully implement QE2,
and Ben Bernanke leaving the door open for QE3, it is a good time to take
a step back and look at the battle between the acceptance of risk and risk
aversion.

This article and video provides updated versions of charts we have presented
in recent months. The market has had several opportunities, from both a fundamental
and technical perspective, to correct in recent weeks, but the bears have not
seized the moment. Charts created months ago are leaning bullish, which bodes
well for risk markets making higher highs in the months ahead. All charts are
as of the Decemebr 10, 2010 close. A larger
video player is available making it easier to read some of the charts.

The spring 2010 rally was abruptly halted by numerous forms of resistance,
including the 190-week moving average shown below (thin blue line). The S&P
500 has recently cleared and held above the 190-week. The chart below was first
presented on December
2nd.

A similar concept is shown below with additional moving averages added to
the chart. Not only has the market cleared resistance on the far right side
of the chart below, but stocks also held at key levels of moving average support
in July 2009, July 2010, and September 2010. When we first presented the chart
below on October
13th with the S&P 500 at 1,170, we stated:

On the high end, a clean break above the 190-week MA (now at 1,184)
and the 205-week MA (now at 1,201), could spark surprising gains to the
upside.

In the last seven weeks, the S&P 500 has cleared and retested important
levels in the form of the 190, 210, and 275-week moving averages (shown in
blue, red, and green below). The longer the market can hold above these levels,
the more meaningful it becomes from a bullish perspective. The chart below
was originally presented on December
2nd with these comments:

This band of resistance from the three MAs (green, red, and blue lines
above) represents a significant test for both the current bull market and
the Fed's quantitative easing (QE) policy. A significant market failure
at the band formed by the 190, 210, and 275-week moving averages may indicate
global deflationary forces are stronger than the Fed's printing press.
A typical bull market would pause near these barriers, but eventually the
primary uptrend would carry stocks to higher highs.

In the monthly chart below, notice how the 70-month moving average (blue line)
acted as resistance on the first clearing attempt in 2004; the second attempt
in 2004 was successful. The pattern in 2010 is similar thus far. The S&P
500 stalled at the 70-month in April 2010. If the S&P 500 can finish December
above the 70-month (now at 1,217), it may open the door to significant gains
just as it did in 2004-2007. The chart below was originally presented on October
14th with the S&P 500 at 1,178. These comments accompanied the original
version of the chart below:

Prices recently held at the 19-month MA, which supports longer-term
bullish outcomes. Notice how the 70-month MA (blue line) held back the
first attempt to cross it in 2004. 2004 is a good comparison to the present
day since we are in a similar part of the market, economic, and interest
rate cycles. The second attempt to clear the 70-month MA was successful
in 2004. In 2010, the first attempt at the 70-month MA failed (just like
2004). The market probably will make a second attempt at the 70-month MA
before we close out 2010. The 70-month MA now stands at 1,216, which is
near other logical forms of potential resistance. Given the relatively
low odds of a double dip (less than 25%), the Fed's near promise to print
more money in the form of quantitative easing, and positive technicals,
we believe the odds favor a break of the 70-month MA in 2010 or early in
2011.

As the updated version (as of 12/10/10) of the chart below shows, the S&P
500 has successfully cleared the 70-month moving average (blue line). The move
becomes more meaningful if it can hold into early 2011.

With the S&P 500 trading at 1,200 on November
20th, we first posted the chart below along with the following:

Whether or not the S&P 500 can hold above its recent closing low
of 1,178 remains to be seen, but there is ample evidence in hand to at
least leave the door open to higher highs occurring between now and year-end.

The market did hold near 1,178, and as shown below in an updated version of
the chart, recently broke out above the blue trendline.

If we take a longer-term perspective, trend channels impacting price since
the 2007 highs have also been cleared (see below) opening the door to possible
further bullish activity in the first half of 2011.

On a weekly chart, the S&P 500 has cleared resistance at 1,220. The next
level to watch on this chart comes in near 1,256, an area where sellers may
surface for a time (see chart below).

The next two charts look at areas of potential overhead resistance for the
S&P 500. In 2004-2005, the area near 1,246 on a weekly chart acted as both
resistance and support. This level may come into play again in 2010-2011.

On a monthly chart, 1,245 also was important to market participants in 2004-2005,
which reinforces the need to pay attention near this level in 2010-2011.

The S&P 500 closed on December 10th at 1,240.40 which is very close to
three potential forms of resistance shown below. Given the bigger picture,
we would expect any pause or correction near 1,240 to be within the context
of an ongoing bull market.

This analysis relates to longer-term trends and does not leave the financial
markets immune to normal corrections, which can be significant within the context
of an ongoing bull market. As long as the key levels outlined above hold, the
odds favor markets making higher highs in 2011. If these levels fail to hold,
it may signal the deflationary forces in the global economy are gaining traction
relative to the Fed's printing press.

Chris Ciovacco is the Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at www.ciovaccocapital.com.

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